The Five ‘Cs’ of Small Business Lending

Evaluating the creditworthiness of a small business may include a number of factors. Most bankers and other traditional lenders have relied on what they call the “Five Cs.”. They’re easy to remember and cover the major questions most lenders will likely want to know—“Can you repay a loan?” “Will you repay a loan?” “Do you have a plan should something happen and you can’t repay?”

Knowing what the loan officer is looking for might help you as you sit across the desk or talk over the phone:

Character: Most lenders are just as interested in your character as your credit score—although they consider your credit score to be part of the character equation. Most lenders realize there are relatively few “perfect” borrowers, which is why they look at your history as a business owner, your management team experience, and your business reputation within your industry. If these look good, even if your personal credit score or your business credit profile has a blemish or two (and there are extenuating circumstances that may have contributed to it), and you’re prepared to explain what happened and what you’ve done or are doing to improve the situation, you might still qualify for a small business loan.

Credit: It’s on my list as number two, but in reality should probably be number one. It’s what most lenders look at first when evaluating a small business borrower. Even a banker who wants to give you the benefit of the doubt will likely have a personal credit score threshold he or she can’t go below. You should also know that every lender weights personal credit score differently and may have a different threshold. If you’re going into the bank, you’ll likely need to have a credit score of 680 or better. The SBA will guarantee a loan with a credit score of 650 or better. Many non-bank lenders will go lower provided other metrics like time in business and cash flow are sufficient. This factor and how they feel you measure up to the first C try to answer the “Will you repay a loan?” question. Although “credit score” refers to your personal credit score, you can’t afford to ignore your business credit profile either. It can often make the difference when applying for a small business loan.

Capacity: This is why a lender may ask about revenues and cash flow so the lender can evaluate whether or not you have the cash flow to make your loan payments. This is how they try to answer the “Can you repay a loan?” question. No lender should be interested in giving a loan to a small business owner who doesn’t have the ability to make the required payments. This makes a small business loan particularly difficult for early-stage startups that aren’t generating any revenue yet.

Capital: Lenders typically like to see that you have invested some of your own capital into the venture—that you have a little skin in the game. They may also want to see capital amounts that exceed the loan amount. It’s not surprising then if a frustrated small business owner might think, “If I had that, I wouldn’t need a loan!” Nevertheless, if a lender sees you invest some of your own cash into your venture, he or she may feel you’re less likely to walk away if things get tough. Having some cash on hand for day-to-day needs and maybe even a little set aside for a rainy day also tells the lender that the business loan you’re looking for isn’t a last-ditch effort to keep your head above water for the next few months while your business falters.

Collateral: Lenders may look to secure assets like real estate or equipment as collateral, though anything of value that is relatively liquid may also suffice. Collateral reduces the risk to a lender by providing something of value in the event of a default. Although not all lenders look at collateral the same way, you should expect to be asked about whether or not you have collateral to secure a loan.

Now that you know the Five ‘Cs,’ you can objectively look at your business and determine how you measure up. Finding ways to mitigate weaknesses is often what determines who finds success and financing, and who doesn’t. When you know the typical questions in advance, it’s much easier to pass the test.